U.S. stocks got a lift from Caterpillar’s Q3 earnings results and the company’s raised guidance for Q4 – that increased guidance boosted optimism that weakness in Chinese factory activity is short lived.  The latest adjustment on a mortgage refinancing program and the hope (or a more accurately a pipedream) that EU ministers will get the next debt/banking industry backstop right may have also played a role.  EU officials are expected to unveil the next great bailout proposal tomorrow.

Basic material, financials and tech led the rally.  Telecoms, staples and utilities underperformed as all three closed lower.

As I talk about so often, we can’t get stock price higher without dragging the price of oil right along with it.  It’s my view this positive correlation is a result of the Fed juicing the market – if they’re going to push investors into riskier assets by pumping money into the system and making the return on safe assets horribly unattractive (from a rate scenario), then the geniuses within the FOMC cannot direct to which risky asset cash goes.  Crude closed up $4.10 to $91.50/bbl.  That’s a four-fold gain in percentage terms relative to the rally in stock prices, a jump driven by more Fed comments – both Dudley and Yellen (part of the FOMC’s Big Three) talked about the central bank rolling out more QE.

And on that note of the Fed pushing people into stocks as they zero out the return on safer assets,, it reminds me of a quote from the South Sea Bubble of the 18^th century.  When the president of Martins Bank (the Goldman Sachs of the era) was asked why he paid $500/share for South Sea shortly before it collapsed he replied:  “When the rest of the world is mad, we must imitate them in some manner.”  Whenever I hear people state that investors must buy stocks simply because the return on safer assets has been decimated by Fed action I think of that quote.  If one is going to buy stocks as part of a long-term investing strategy, then that is one thing.  However, those who are lurching into stocks for short to intermediate-term returns merely because returns on safer assets have been manipulated away by the FOMC, that is certainly a much more dangerous activity.

More below the click…

Market Activity for October 24, 2011

Sector Activity for October 24, 2011

Europe and the HARP

As the market stays focused on the EU’s latest proposal to assuage/fix their debt problem, the manufacturing data out of the Eurozone continues to suggest recession lurks.  The zone’s manufacturing gauge fell to 47.3, marking the third-straight month in contraction mode – a number below 50 means activity declined.   And for the economic engine of the zone, Germany’s specific factory gauge fell below the 50 mark for the first time since April 2009.

And then here at home, regulators announced details of a new plan to help home borrowers lower their mortgage payments even if that mortgage is hugely underwater – it doesn’t matter how deep that mortgage is underwater so long as the payments are current and the loan is owned by Fannie or Freddie.  This is an adjustment to an existing program known as the HARP (Home Affordable Refinance Program), which was capped at 125% LTV (the mortgage was 125% of the home’s value) and failed to get the housing market rolling.  The adjustment also removes any risk to the servicer via penalties if the borrower stops making payment, which reportedly was the biggest obstacle.

To take advantage of the program, call your mortgage servicer and ask if Fan of Fred owns your mortgage – if you have a conventional mortgage then almost certainly they do.  At which point, you will be able to refi to a lower rate without an appraisal and supposedly via a streamlined process. The only constraint left is the loan must have been owned by Fan or Fred prior to June 2009 (that is, if you refinanced or purchased the home after May 2009 then you cannot participate.)  The question now is when does the bailout for appraisers begin?

CFNAI

The Chicago Fed National Activity Index (CFNAI) – a gauge of economic activity for the nation as the name implies – printed a reading of -0.22 for September after the -0.59 for August (a number that was initially reported at -0.43 last month).

So what does this number mean?  It means that the economy is growing at a below trend rate – below average.  But we already know this so the figure within the report we watch is the three-month average.  And in this weak environment the number we specifically watch for is -0.70, which is the level that suggests a recession has begun.  That three-month average sits at -0.21, so it’s well above that recession reading – the closest we’ve been to that number is the -0.55 hit in June.

On the other hand, the Economic Cycle Research Institute’s (ECRI) gauge of economic activity has plunged back to the -10 mark – a level that has predicted every recession since 1970, save when it hit that mark in July 2010.  The head economist at ECRI has stated that a recession is a done deal this time.  We’ll see if they’re right.

Sign up to receive the Daily Insight and other Acropolis publications here.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900